The start of 2016 brought with it the launch of Solvency II, rules in the European Union that govern how much capital insurers must set aside for operational risk, investment and underwriting. “Launch” is the key word here, as the vast regulatory framework has only begun to ramp up. More work remains to implement those standards, including efforts to create regulatory reciprocity between U.S. and European regulators.
With that in mind, Carrier Management Editor Mark Hollmer conducted a Jan. 21 interview with Sean McGovern, chief risk officer and general counsel at Lloyd’s of London, about Solvency II, and how the evolving regulatory landscape in general is helping, or hurting, insurers. Excerpts from that interview are below.
How are things going with Solvency II now that it has kicked in?
Obviously, it’s Jan. 1 saw the implementation of a very long-planned and long-running new regulatory regime for the entire European market. It is a very ambitious undertaking, which has taken a long time to deliver.
How has it or will it affect Lloyd’s?
It is early days for us at Lloyd’s for internal model approval from the PRA (the UK regulator). Under Solvency II you either calculate your capital based on standard form, or you can apply to have your own internal modeling approved by the regulator. Nineteen insurers were approved by the PRA in December 2015 and Lloyds was one of those.
That was major undertaking for us, for all the firms who have been implementing Solvency II. It is a very good outcome from our perspective giving the investment we had made in achieving that outcome.
There is far more to come, however, yes?
It is fair to say, you are talking about implementation of a harmonized regime within every member state of European union. The ambition is full harmonization [and a] level playing field across Europe. Post- Jan. 1, there is still further work to be done in insuring practical day to day implementation that it is actually a level playing field in Europe.
How is regulation helping the P/C insurance industry?
Regulation continues to be a major preoccupation and risk for the sector. The challenge we have as a major international insurer and reinsurer is, what we are increasingly finding as we operate globally is the level of regulatory change and regulatory burden is increasing. And the level of convergence of regulatory requirements and standards is decreasing.
What I mean by that is in the post-financial crisis environment we have been through a pretty unprecedented level of financial services regulatory reform in all of our major economies but also many emerging economies. The industry is having to cope with an outcome of wholesale changes both to prudential regulation but also conduct regulation.
We often focus on what is happening in the U.K. or Europe or U.S. But as global operator dealing with all of those same issues in every country in which we operate, that places big challenge in the operation of international business, to run … efficiently from a management perspective but also a capital perspective.
You could argue part of that has been driven by a breakdown of trust by regulators, and that has happened in the past [with the] financial crisis, where obviously regulators are keen to ensure they understand and regulate everything that happens within their country, because of the risk of something going wrong.
Is any regulatory environment good?
Our position is that strong robust regulation is a good thing for the industry.
In our view the pendulum has swung far too far, in situations where regulation is at risk of creating some unintended consequences, which could damage the interests of our customers.
Clearly the cost of regulation ultimately is something that is a cost to business, and something that is ultimately priced into products, just as all business costs are. More concerning is the regulatory framework that has been built over the last six-to-seven years since the financial crisis. Is that creating conditions in which insurance sector can innovate effectively to respond to changing needs of our client base, or is it hampering innovation in the sector? I think there are many in the industry that would say it is probably a net negative in their ability to innovate quickly and respond to a very dynamic and changing world of risk.
What regulatory hurdles are coming down the pike that are causing the most concern?
it is not so much a hurdle but a very topical issue both for us and U.S. industry. We have been talking for a very long time now about the relationship between the U.S. system of regulation and the European system of regulation. That is a dialogue that has been now going on for almost a decade. With Solvency II having now gone live, we are now keen to support the process that is now getting off the ground between the U.S. and EU sides in negotiation of a covered agreement.
The relationship between EU and U.S. regulators has been somewhat fraught at times. For the industry, it is important that international business done by Lloyd’s and for U.S. businesses that operate internationally, [to have] regulatory dialogue between the two largest markets in the world, to get mutual understanding and mutual respect for each others’ systems of regulation.
What does a successful outcome look like?
That those negotiations get to point where they agree to mutually recognize each others’ systems, and if the U.S. will be found equivalent under Solvency II. Obviously, Bermuda, Switzerland and Japan have been found to different degrees as equivalent. The U.S. issue has to be resolved to give certainty to U.S. businesses operating in Europe.
From my perspective, it is important that this resolves a longstanding issue Lloyd’s has campaigned on, the removal of a reinsurance collateral requirement [100 percent requirement] for European reinsurers to post collateral in the U.S.
The outcome we should all be striving for is a level playing field between the U.S. market and the European market. It is in the interest of carriers on both sides of the Atlantic.
What is the broader prize?
If the two largest insurance markets can resolve their differences and mutually recognize each others’ systems of regulations, it sets the standards for other markets to follow. It can only help other international carriers in the U.S. and Europe to penetrate other markets around the world. There is a broader prize in achieving that outcome.